View from London: It's Not Always About Interest Rates

Not all tools are created equal and the power of the rate hike by central banks has been mostly forgotten in the last eight years, writes Bob Savage, CEO of Track Research.

Lesson of the day – it’s not always about interest rates – as the weekend stories show. Even so, the urge for markets and politicians is to push central banks away from discretion and onto more mechanical reaction functions.

Not all tools are created equal and the power of the rate hike has been mostly forgotten in the last eight years. The Abe victory sent the Japanese yen (JPY/USD) lower with 115.50 the key target. He gained enough seats to contemplate constitutional change (2/3 super majority) and that maybe a distraction from enactment of the third arrow for reforms, but its balanced by expectations that BOJ Kuroda likely remains at the central bank keeping QQE and 0% 10Y rate target.

UK PM May faces the Labour push to rebel Tories over her Brexit bill – but with Merkel and Tusk comments, the mood for soft deals rising even as the BOE expectations for a November hike fell from 87% to 79%.

For the euro (EUR/USD), the ongoing focus on Catalan independence and the rise of the populists after the weekend Czech elections are a brake to the ECB expected tapering timeline discussion.

Lombardy and Veneto votes to favor more autonomy away from Italy’s central government – while legal and non-binding – add to fears about the elections in 2018.

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All points for the ECB lead to when is the first rate hike and what it does to the EUR while the politics help more than Draghi in capping the single currency under 1.1880.

The lesson being that rates aren’t always the driver for forex particularly British pound (GBP/USD) where the BOE is the unreliable boyfriend and in the EUR where politics remain ugly.

For the U.S., obsession over whether its Powell or Taylor or Yellen to chair FOMC in 2018 dominates press but the markets are paying attention to the House and tax reform – watch for adaption of the Senate 2018 budget as a trigger for more stock and U.S. gains beyond rates.

There are limits, to arguing that rates don’t matter, as the RBI minutes dashed some hopes in India for a rate cut with debate over stimulus while in Korea, the good times are making a BOK rate hike more likely.

In Russia, expectations for a rate cut from the central bank cap gains in the Russian ruble (RUB/USD) even as oil rallies further on OPEC production cut extension talk.

The point is that unless we get U.S. rates to break out from 2.45% resistance, the USD is going to move for other reasons – in the case overnight foreign politics and politics, and at home, more hope for tax reform.

For trading markets, the EUR/USD is the key for the week with the ECB decision and tapering talk central to moving any needle in FX let alone longer-term rates. The risks are that Draghi takes up the BOJ lesson and starts to target longer term rates and give up on QE as the only game.

Pegging 10Y Bunds at 0.45% might mean the EUR stays under 1.1880 for some time.